For a successful business – managing cash is NOT an optional “to do.” In particular, because (more often than not) they lack sufficient capital, cash management plans are essential for small businesses. If a business does not forecast or have a plan to address cash shortfalls in periods of slow growth or unexpected costs, it runs the risk of being unable to pay it’s employees, service it’s debt or pay it’s vendors. Each of these situations could force the business to sell some (or all it’s assets), downsize to save money or discontinue/disband operating to settle it’s obligations.

My Firm is about helping the small business owner with practical tools.  So let me address a topic no business wants to discuss or acknowledge-Failure.  Businesses fail for a variety of reasons, but near the top of the list is they do not budget for or manage their cash.  It’s this lack of discipline that causes a liquidity crisis and in the ensuing stress makes them throw up their hands, exclaim “screw this” or maybe something more colorful, and literally give up on their dream and their business.

I’m not advocating that a business owner spend hours upon hours creating extensive, intricate Excel Spreadsheets.  That’s crazy.  But businesses need to understand risk and lacking even a rudimentary plan to estimate the amount of cash your business needs, places your business at further risk.

Some people may disagree with me on the importance of planning.  This post is targeted to those owners that appreciate and value planning.  Planning forces you to understand your business, much better.  Over time, as you accumulate data you will understand the “dips” and “swings” in your operation and you will be able to anticipate and put in place, tactics to minimize or eliminate issues before they become problems or worse.  The best managed companies ALWAYS plan and some do very well even in an economic downturn.  But planning requires time and thought for it to be accurate and therefore, relevant and reliable.

Two quick statements.  The Accounting Platform, itself is nothing more than a tool to help you develop a good plan.  But problems occur when the transactions, the source data and the records, that are input, are themselves incorrect, misstated, or worse, intentionally misleading that create all sorts of havoc, and owners relying on this data can make terrible decisions.  A solid plan starts with good data-no mystery.  One other comment-if you cannot separate your personal life and situation from your business, and you commingle the two, chances are, you’re going to create a very unhappy situation for you and your business, and a plan with little or no relevance-but I digress.

Business owners, more often than not regard Accounting as a necessary obstacle-something they must comply with to avoid trouble.  They amass this huge reservoir of data with little or no thought as to how to use it to help them manage their operations, plan more effectively and execute those plans, more efficiently.

In this age of disruptive technology, small business owners have a plethora of Accounting Platform options to choose from, some web based with low monthly fees.  I use QuickBooks Online.  These platforms allow owners to capture transactions and records and over time, give them the ability to understand trends.  Businesses, especially those that are seasonal would find it beneficial to understand how their operation is impacted over time to anticipate problems and create plans to address them.

In this short post, I wanted to put together something that I thought would be helpful or insightful for the small business owner to address cash needs and lay a foundation to develop a simple cash management plan-using a common financial ratio called a Current Ratio.

Current Ratio = Current Assets / Current Liabilities

If your eyes are glazing over, or you’re getting bored, please, stick with me.

If you don’t have the time or inclination to create a cash budget…you should, at the very least understand the amount of pressure that your liabilities are going to put on your cash, particularly if you have creditors and you’re on the hook for interest and possibly balloon or principle payments.  Assuming that your Bookkeeping and records are up to date, you can run reports to understand when these bills are due and for how much over your fiscal year.

Simply put, you must have sufficient current assets to pay down your current liabilities.  Aside from your bank accounts, current assets consist of inventory or anything else that you plan to convert to cash in the current fiscal year.  Current liabilities, consist of Accounts Payable, taxes payable, interest payable on any notes or debt and any portion of the principle that is payable in the current fiscal year.  There may be other obligations that are more complex in nature imposed by creditors, but I’m simplifying this for brevity.

As an example, if you’re a merchandiser, and you have outdated or obsolete inventory, you will want to consider the value that you would expect to receive if you tried to sell it.  Be realistic.  If you had to write the inventory down by 40 or even 50% to sell it, less any selling costs, then that’s what it’s worth!  In all likelihood, it will not get more valuable over time, unless we’re talking about a ’59 Gibson Sunburst LP, Standard Guitar.

So, if you were to run a report for your current fiscal year, and you find that your current obligations (by quarter) were:  $65K; $80K; $105K; and $90K, then this is the amount of liquidity you would need to pay these obligations off-in total, $340,000.

This is not whole story.  Far from it.  A cash budget considers not only liabilities but what you expect to pay for expenses (items that you pay for immediately), including compensation, and any capital or fixed asset investments.  Non-cash expenses are excluded.  It should also include a “cushion” as an additional percentage to address those pesky unforeseen things that always seem to arise.  This is evaluated against the amount of cash you expect to collect from customers/clients and those assets that you expect to convert to cash.  Looking at the history of your Accounts Receivable Aging would be helpful for the timing of these inflows.  Cash from customers/clients can be estimated from revenue less any discounts or credits/refunds that are anticipated.

A final note.  Net Income is a measure of Operating Effectiveness, not cash.  You can be rich on paper but cash poor.  How?  Liabilities/Obligations/Debt!  This is what chews up your cash.  And, the act of paying down debt is NOT an expense.

I hope this was helpful in describing why cash management plans are essential for small businesses. Constructive comments are always welcome.  If you would like to understand how we can help develop your plan, contact us HERE. 

Here’s to a great and prosperous New Year!